1997’s Top Ten Lab Stories Predict New Directions

Review of top lab industry stories for 1997 demonstrates how the marketplace is shifting

CEO SUMMARY: Events during 1997 reveal that the laboratory industry continues to undergo fundamental change. Yet even amidst the industry’s downsizing, selected laboratory organizations continue to flourish. Here is THE DARK REPORT’s annual look at top stories for the year. A careful analysis of their impact leads to some interesting conclusions.

WHEN FEDERAL REGULATORS introduced a rigorous laboratory compliance program last February, few laboratory executives understood the major ramifications of this development.

After all, it was the $325 million settlement between SmithKline Beecham PLC and the federal government which attracted headlines. It was a huge recovery by the government, and allegations against SmithKline included a variety of business practices, some common throughout the laboratory industry.

But the real news was not SmithKline’s settlement and fine, it was the unexpected introduction of a laboratory compliance program. Government prosecutors, after investigating virtually every large commercial laboratory and a host of hospital laboratories, decided that violations of Medicare fraud and abuse statutes were both widespread and ongoing. To stop these practices, regulators want each laboratory organization in the United States to institute a rigorous compliance program. For this reason, laboratory compliance is recognized as the top story of 1997.

In announcing the requirement that laboratories would need to develop compliance programs, government enforcers put serious teeth into the consequences of failure. As laboratory executives learned about the requirements for a laboratory compliance program, they made a disturbing discovery.

Both the Department of Justice and the Office Of Inspector General (OIG) declared that violations of Medicare coding and reimbursement guidelines would henceforth be considered serious enough to warrant criminal charges and jail time for any laboratory manager deemed responsible for a laboratory’s failure to follow the compliance program.

This laboratory compliance program is 1997’s biggest story for two reasons. First, every laboratory in the United States must respond. Second, a personal threat of civil and criminal charges now confronts every laboratory manager with oversight responsibility for Medicare billing and reimbursement activities within the laboratory.

These stories are evidence of the ongoing market forces now reshaping both healthcare and the clinical laboratory industry.

Excluding the bombshell news of universal laboratory compliance programs, 1997 might otherwise be viewed as a “quiet” year. None of the remaining stories in our top ten list has either the drama or serious impact of the heightened government regulation of laboratory activities.

However, the other top stories on our list are not inconsequential. To the contrary, each of our top stories will influence and change traditional laboratory practices. These stories are evidence of the ongoing market forces now reshaping healthcare and the clinical laboratory industry.

Ranking By Importance

Ranking the relative importance of our top ten news stories for 1997 is difficult. Does the arrival of pathology practice management companies rank higher than the financial struggles of national HMOs? Does consolidation of the diagnostics industry have more importance than introduction of automated cytology technology?

We believe that individual laboratories would prioritize our list differently, based on how they see the impact of these stories on their operations. Accordingly, we present the top stories of 1997 “as-is,” with no attempt to prioritize their importance.

It is worthwhile to note that these top stories cover a range of management issues in the laboratory industry. For example, the diagnostics industry is about to undergo a wave of consolidation. Diagnostics companies supply laboratories with instruments and reagents. Turmoil caused by mergers and acquisitions will directly impact how these companies service their laboratory customers.

Continued growth and profits of specialty and boutique laboratories indicate that some clinicians and payers still value diagnostic testing. But even as specialized reference and esoteric laboratories prosper, those laboratories performing high volumes of routine testing continue to see significant declines in their reimbursement.

HMO Financial Woes

Financial woes of national HMOs presage continued financial pressure for clinical laboratories. If the HMOs cannot make money themselves, how can they find extra funds to increase laboratory reimbursement? This is one developing story which THE DARK REPORT predicts will have major impact on the financial health of large laboratories during the immediate future.

Pathology is about to undergo a radical similar market transformation. The fact that venture capitalists are willing to fund pathology-based physician practice management companies is evidence of their belief that new business models can out compete existing pathology practices.

Add up the impact of these “top ten” stories for 1997 and one conclusion jumps out: 1998 will be a year of continual and dramatic change, both for clinical laboratories and for pathology.

1. Laboratory Compliance Program Follows SmithKline Settlement

AFTER SmithKline Beecham agreed to pay $325 million to settle allegations of Medicare fraud and abuse last February, news media publicized the agreement as the largest healthcare fraud case ever to be settled.

For the laboratory industry, the real news was not the size of SmithKline’s settlement, but the simultaneous announcement by federal authorities that clinical laboratories should immediately implement a compliance program.

Although the implication was that such compliance programs would be a voluntary act on the part of laboratories, federal prosecutors made it clear that any future allegations of Medicare fraud and abuse would include harsh penalties. Not only would there be civil fines, but prosecutors declared their intention to pursue criminal charges against both corporations and their executives.

If any laboratory executive doubted the seriousness of this threat, they had only to see what federal prosecutors did to executives at Columbia/HCA Healthcare. After widely-publicized raids in April and June, three of Columbia’s executives in the Florida division were indicted in July. (See TDR, August 4, 1997.)

Laboratory compliance programs only mark a first step in what will become a major intrusion by the government into every aspect of clinical laboratory operations. Genuine concerns about healthcare fraud will prove to be the Trojan Horse used by the government to interfere in lab operations.

2. Niche and Boutique Laboratory Providers Enjoy Growth, Profits

COMPARED TO the financial performance of commercial labs, boutique and niche laboratories demonstrated surprisingly strong growth in revenue and operating profits during 1997.

This illustrates that it is still possible for laboratories to make money in a managed care world. But the profits will not got to laboratories offering routine tests and common reference assays.

Instead, the performance of diagnostic laboratory providers such as UroCor, Inc.; DIANON Systems, Inc.; ImPath, Inc.; Rheumatology Diagnostics Laboratory, Inc.; Endocrine Sciences and others derives from their ability to provide value-added services to a specialized segment of the healthcare community.

Not only do these specialty laboratories offer diagnostic tests which have high value to clinicians, but the need to tailor testing and related services to the clinicians ordering these assays naturally creates tighter bonds between these laboratories and their physician clients.

In 1998 and beyond, routine laboratory testing will continue to be consolidated into regional laboratory centers. Reimbursement for such testing will continue to decline.

Meanwhile, specialty testing will increase. Because of the high value placed on such tests by clinicians, specialty test providers will generally earn higher profit margins than their general reference laboratory competitors.

3. What Didn’t Happen in 1997: A Cascade of National Lab Contracts

HERE IS A STORY WHICH IS SIGNIFICANT because it didn’t happen! As national HMOs continued to grow and expand, many observers expected these companies to negotiate exclusive national contracts for laboratory services.

But only United Healthcare announced a national laboratory contract, involving SmithKline Beecham Clinical Laboratories and Laboratory Corp. of America. No other national HMOs moved to follow the example of Cigna Healthcare, which did a sole-source, exclusive national laboratory contract with SmithKline in 1995.

Had most other national HMOs and insurance corporations followed Cigna’s example of an exclusive, sole source contract for national services, both small regional laboratories and hospital lab outreach programs would have been severely impacted.

Maybe the real story lies in the difficulties experienced by both Cigna and SmithKline in making the 1995 contract work. Although both companies publicly state that the relationship has been satisfactory, regional laboratory providers in various parts of the country tell a different story.

There is another reason why national laboratory contracts failed to appear at other large HMOs. The HMOs themselves now struggle with problems resulting from their own expansion, so management is focused towards other areas. But a current reading of the market seems to indicate that national contracts will be less of a threat than was considered true in 1995.

4. Venture Capital Markets Support Formation of Pathology PPMs

AFTER 1997, THE PROFESSION of pathology will never be the same. Pathology-based physician practice management (PPM) companies arrived on the scene with much bally-hoo and fanfare.

4. AmeriPath, Inc. was the first pathology PPM to appear. Funded by venture capitalists several years ago, it successfully went public in October. Its initial public offering raised $89.6 million. In December, Physician Solutions announced an agreement to access a capital line of $18 million, also funded by venture capitalists.

Like it or not, it is the venture capitalists which provide the capital for these companies to pursue their vision of what the business of pathology should be. Money talks, and AmeriPath has already spent $200 million buying pathology practices.

Irrevocable market forces are now unleashed. Pathologists will be confronted with a serious decision. Should they sell their practice to a PPM? If not, what should they do to compete against pathology PPMs?

The more sophisticated business minds among pathologists already appreciate that the real dilemma is not whether to buy or sell their practice. The real dilemma involves the correct strategy to fend off these PPMs when they send their sales reps to hospitals to capture anatomic pathology contracts. Pathology PPMs are a direct threat to hospital-based pathologists.

5. National HMOs Find Themselves Facing Sustained Financial Woes

HERE MAY BE THE MOST OVERLOOKED story of the year. HMOs are losing money, with no clear turnaround date in sight. Indications are that the HMO industry suffers from serious operational problems which may take some time to overcome.

Financial health of the national HMOs is a prime concern to all healthcare providers, not just laboratories. If HMOs cannot make money, they will attempt to lower reimbursement even further. This increases financial pressure on healthcare providers, particularly clinical laboratories.

Prudential’s fiscal woes have been public for several years. But Wall Street was surprised by a string of announcements during the last half of 1997, as Oxford, Aetna/US Healthcare, PacifiCare and others revealed their struggles to maintain operating profits and earnings.

From a practical perspective, adequate reimbursement can only flow from financially healthy HMOs. THE DARK REPORT believes that HMOs and managed care plans as we know them today will not be the final or best solution to healthcare. But during the short-term, ailing HMOs will only complicate the financial challenges confronting clinical laboratories.

This is an important story. All laboratory administrators and executives should carefully track the financial performance of the largest HMOs. Should they continue to do poorly, laboratories and other providers will bear the burden.

6. Automated Cytology Systems Gaining Marketplace Acceptance

IN 1996, AUTOMATED CYTOLOGY SYSTEMS were a novelty. During 1997, these same systems became a regular feature in the marketplace.

Currently only a limited number of laboratories actually use these products. But that will rapidly change. Ongoing sales and marketing campaigns by the three major vendors of automated cytology systems are building awareness of their products among laboratory executives.

More importantly, collective efforts by these three companies to obtain appropriate CPT codes brought about exactly that result. Starting in 1998, there are CPT codes for the automated cytology procedures. In response, a few managed care plans are announcing their willingness to reimburse automated cytology procedures.

Although many laboratories nay-sayed this technology, THE DARK REPORT consistently predicted that it would eventually carve itself a place in the market. That seems to be occurring, although at a slow pace.

The added cost of this technology is an issue. But clinical use of this technology generates an ever-growing body of data as to the clinical and economic effectiveness of automated cytology systems. The actual performance of each technology in the marketplace will determine its fate. If these systems provide clinical value, data will demonstrate that. If they cost too much, economic data will demonstrate that too.

7. Paradigm Shift: National Labs No Longer Bullies In the Market

DATING FROM THE MID-1980S, large commercial laboratories dominated the marketplace. In 1997, that ceased to be true.

For many years, hospital labs and the independent commercial laboratories resented the way the national labs used loss-leader pricing to scoop clients and market share away from local competitors. Small competitors were unable or unwilling to match sales strategies that ranged from test unbundling to client-bill discounting on high-volume, routine testing.

Because of these, and other practices, national laboratories dominated the price and service infrastructure of each local market. Smaller competitors were at a disadvantage because they lacked sufficient capital and market clout.

That is changing. After several years of huge losses, the three blood brothers were forced to acknowledge their sins. Old business practices and attitudes have been tossed aside. The national labs are quietly evaluating individual accounts on the basis of profitability. They are eliminating excess laboratory capacity. Contracts are renewed at higher prices wherever possible.

Yet none of that will help. THE DARK REPORT was the first publication to chronicle the success of local laboratory competitors against the nationals. In market after market, a well-managed local lab, armed with a professional sales program and good service, is building market share at the expense of their national competitors. The pendulum now swings away from national labs.

8. Lab Administrators Finally See Need to Change Lab Operations

AFTER MANY YEARS OF DENIAL, a growing number of hospital laboratory administrators now acknowledge the need for change. As a result, the pace of hospital laboratory restructuring and re-engineering will increase.

Whereas in previous years, most hospital laboratory administrators would offer all sorts of reasons why there was no need for them to restructure their laboratory, that has ended.

Evidence of this change in attitude was visible at laboratory industry meetings throughout the United States in 1997. It was clear that most laboratory administrators were past the stage of outright denial. But this attitude adjustment does not mean that these same laboratory administrators will suddenly become pro-active change agents. These laboratory administrators have a habit of maintaining the status quo. Thus, it will be difficult for them to initiate the necessary management projects which improve the competitive position of their laboratory.

Such projects inevitably mean staff reductions. Most administrators are not yet ready to launch such actions on their own initiative. But their revised attitude towards the need to change will have a positive impact.

As hospital administrators direct that laboratory restructuring take place, these laboratory administrators and directors will respond with less entrenched resistance and obstructionism than in past years. Consequently, the overall pace of laboratory restructuring in the industry will increase from 1997 into the future.

9. Diagnostics Industry Entering Early Stages of Consolidation

COMMERCIAL LABORATORIES underwent consolidation. Hospital laboratories are currently consolidating. Now it is the turn of the diagnostics industry.

During 1997, Roche Holdings, Ltd. acquired Corange, Ltd., owner of Boehringer Mannheim, GmBh. The acquisition made Roche the largest diagnostics company in the world.

In September, Beckman Instruments, Inc. purchased Coulter Corporation. Both companies were dominant in their market segments of chemistry and hematology, respectively. The combination of the two companies has created a powerful competitor.

These are significant events. During 1998 and 1999, there will be further mergers among various diagnostic companies. The Roche and Beckman acquisitions created fundamental shifts to the marketplace. Competing diagnostics firms must respond if they are to maintain a strong competitive presence within the laboratory marketplace.

Expect to see this consolidation activity change the way diagnostics companies package and price their products. With fewer, but larger buyers, one big difference will be the bundling of related instruments. “Per Click” pricing and similar offerings will appear in the marketplace.

As new technology enters the marketplace, it will require more capital and market clout to survive. Thus, many of the smaller diagnostics companies will be gobbled up by the diagnostics giants as consolidation proceeds.

10. Private Insurers Sue SBCL, Adopting Federal Lab Regs

IT IS INCREASINGLY COMMON for insurance plans to adopt Medicare guidelines as the way they require laboratories and pathologists to code and bill for private plan services. Here’s a major development which promises radical change. Yet most laboratory managers are unaware of its potential impact.

In August of 1997, a group of 37 private insurers filed a lawsuit against SmithKline Beecham, claiming that the laboratory company had defrauded them by as much as $1.5 billion. The insurers base their claims upon the similar issues raised by federal prosecutors in their $325 million settlement with SmithKline. This group of insurers represents a sizeable chunk of the covered lives in the
United States, so its decision to sue SmithKline is highly important.

THE DARK REPORT believes that private insurers are struggling to properly administrate claims for private services. This creates pressure to unify and streamline their processes for claims administration. They are finding it easier to use Medicare guidelines as a standard than to create and sustain their own guidelines in parallel with Medicare.

Because Medicare guidelines are designed by bureaucrats, they are already poor reflections of the free marketplace. The adoption of these guidelines by private insurers will only complicate the lives of laboratories and other providers.

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